SEC Prepares Hedge Fund Investor Sophistication Qualifications

SEC is weighing up sophisticated investors sophistication.

Under recently updated rules, most investors can only invest in hedge funds if they are accredited: that is, if the person or couple’s joint net worth exceeds $1 million, excluding the value of their primary residence, or if an individual’s income has exceeded $200,000 in each of the two most recent years — or joint income with a spouse exceeded $300,000 for those years — with a reasonable expectation of the same income level in the current year.

In its August 29 proposal, the SEC said it would be “impractical and potentially ineffective” to require that hedge funds use specific verification methods in light of the numerous ways in which a purchaser can qualify as an accredited investor.
The SEC did concede that it was concerned that specific rules related to verification could become overly burdensome. A set of steps may not apply in all circumstances and in some circumstances may not actually verify accredited investor status.
The HFA says it is happy with the SEC’s first draft, but it just wants the regulator to spell out this view more specifically so there is no ambiguity and the onus is clearly not on the hedge fund firm to verify that the investor told the truth.
“If they certify they are accredited and lie, there is no reason we should take the risk,” says HFA board member George Schultze of Schultze Asset Management.“The purpose of the law is to create jobs by simplifying the process to get investors,” he says. “Otherwise, it would be one step forward and three steps backward.”
Interestingly, the SEC is seemingly taking the opposite approach of Department of Homeland Security and U.S. Immigration and Customs Enforcement, which enforce immigration laws by aggressively targeting employers as to whether or not they verify the employee’s legal status.
Schultze, however, says you can’t compare verifying legal residency and citizen status with whether someone is an accredited investor. He says the SEC’s rule is designed more to protect the investor from fraud.
“Sophisticated investors can make their own decisions,” he said.

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